Question

Assume an open, mixed economy. That is, foreign trade is part of the economy, and the economy includes both a public (government) and a private (consumers and businesses) sector. Given this, aggregate demand is expressed as (C + I + G + X). Assume the MPC is .7. Assume a stimulus package of $100 billion has been approved by Congress and the money has been spent. In order to pay for those expenditures, Congress also approved a $100 billion increase in individual income taxes. (This means Congress would not allow deficit spending in order to stimulate the economy.) Will these actions by Congress expand or contract the economy or are they just useless actions? Get started early and work with your class members to solve this problem.

Note: Go back to the Policy Example using North Carolina as an example in Chapter 6 in your text. This is sort of the opposite scenario for the state of North Carolina. Can you see that?

Answer 1

WE KNOW THAT THE GOVERNAMENT INCREASES $100 BILLION GOVERNAMENT EXPENDITURE AND SIMULATANEOUSLY INCREASE TO THE TAX BALANCE THE BALANCE BUDGET MUTIPLIER =1

WE KNOW THAT THE INCREASE IN$100 OF G AND TAXES WILL INCREASES GDP BY$100WILL I BECAUSE GOVT EXPENDITURE MULTIPLIER= 1/1-MPC=1/1-0.7=3.33

THUS AN INCREASE IN G BY 100 WILLL INCREASE Y=333.33 AND INCREASE IN TAX 10 WILL REDUCE INCOME BY TAX MUTIPLIER CHANGE IN TAX

TAX MULTIPLIER = C/1-C=0.7/1-0.7=-0.7/0.3=-2.33

THUS AN INCREASE IN TAX BY 100 WILL REDUCE Y BY 233.33

THUS NET CHANGE BY Y= 333.33-233.33=$100

SO FINALLY ECONOMY WILL EXPAND THE ECONOMY BY$100